Inside the Business War Against Tax Reform

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About the same time, in a meeting at P&G's headquarters in Cincinnati, Representative Steve Driehaus (D-Ohio), whose district includes the city's downtown, heard what he calls "a very persuasive argument" that Obama's plans would hurt P&G. Under current law, P&G pays an effective rate of 25%. The company has attributed the lower rate, in part, to rules on taxation of foreign earnings that Obama wants to change. Jon Moeller, P&G's chief financial officer, spent 90 minutes telling Driehaus that Obama's foreign tax proposals would put P&G at a 15% to 20% cost disadvantage compared with certain rivals. Driehaus says the P&G arguments confirmed his independent view that any tax changes should be "taken up as part of overall tax reform, not piecemeal." That's Washington code language for a delay in any action.

Just down the street, in Cincinnati's federal courthouse, a different aspect of P&G's effort to reduce taxes on overseas income has been under scrutiny for seven years. The IRS has accused the company of using a Barbados subsidiary as an "abusive tax shelter" to claim more than $80�million in improper savings during 2000. The company allegedly routed hundreds of millions of dollars of sales to its Canadian operations through the Barbados subsidiary. P&G allegedly created fictitious losses to lower its taxable income. The sums at issue aren't huge for P&G, which had earnings last fiscal year of $13.5�billion on revenue of $79�billion. But the IRS was so concerned other companies were using the same shelter that in 2004 it alerted its auditors about the alleged P&G maneuver.

The IRS discovered the P&G arrangement in 2002, when it asked companies to report participation in tax shelters. In response to the IRS objection, P&G sued the government in 2006. The company lost last year and now is appealing. In its appeals brief, P&G argues that the losses generated through the Barbados subsidiary were not fictitious and that the company used proper accounting. "The [trial] court's holding disregards the clear text of the regulations," the company contends. A P&G spokesman declined to comment.

Repatriation Dispute

Schering-Plough, the Kenilworth (N.J.) drugmaker, has joined P&G in the Washington tax-lobbying trenches. Since the fourth quarter of last year, its advocates have visited about 75 lawmakers or their staffers, a spokesman says. Meanwhile, the manufacturer of allergy drug Claritin and erectile-dysfunction medication Levitra is still fighting with the IRS over an arrangement that allegedly resulted in the company improperly deferring $473�million in taxes in 1991 and 1992. The arrangement involved bringing back to the U.S. $690.4�million in earnings from the company's Irish production facilities, according to filings in federal court in Newark. The money allegedly was routed through other subsidiaries in Switzerland to make the purported attempt at tax avoidance more difficult to trace, according to the Justice Dept., which represents the IRS in the case.

When a company "repatriates" overseas earnings so the cash can be used in the U.S., it is supposed to pay U.S. taxes on those funds during the year of repatriation. But Schering allegedly structured the deals to look like it was selling two complex financial investments to its Swiss subsidiaries in return for the cash. The government contends the company then improperly amortized the tax payments on the sales proceeds over a 15-year period, lowering its annual tax burden.

Schering declined to comment on the case, which went to trial this spring and is awaiting a judge's decision. In court papers, the company contends it followed all tax laws. "The IRS chose to make new rules," Schering argues in one filing.

In addition to its broad provisions, the Obama plan narrowly targets certain industries, including energy. The White House estimates that the repeal of nine tax breaks geared to oil and gas companies would bring in more than $30�billion over the next decade. One targeted provision currently allows oil and gas companies to expense immediately most costs associated with the preparation and development of new drilling sites, rather than the typical method of amortizing the costs over a period of time. The resulting tax benefit for oil and gas companies is estimated at $3.3�billion over the next decade.

Beyond the proposed energy-industry-specific changes, major oil producers are concerned about the Administration's efforts to bar certain accounting practices that allow them to lower their tax bills. The main technique is known as LIFO, for "last in, first out." Energy businesses buy crude petroleum at a range of prices. For accounting purposes, they often match sales of refined products with higher-cost batches of crude. That approach minimizes paper profits and decreases tax liability. The companies keep cheaper crude oil in inventory, where it may stay indefinitely.

Use of the LIFO method—which is legal—boosted ExxonMobil's (XOM) $45�billion bottom line by $341�million last year, according to securities filings. Obama's 2010 budget seeks to repeal this accounting technique, a change that would net the Treasury more than $60�billion over the coming decade. ExxonMobil spokesman Rob Young declined to comment on any specific proposal but said "new taxes would make it more difficult for us to invest in energy development" in the U.S. Companies that would be affected by the alteration have swarmed Capitol Hill. A LIFO Coalition, formed in 2006, when the accounting method was first considered for repeal, has been showcasing smaller businesses that use LIFO, such as grocers and jewelers.

Armed with talking points provided by the American Petroleum Institute, the industry's lobby in Washington, company employees describe the risks to their livelihoods. Jim Ford, the institute's vice-president for government affairs, explains: "We're demonstrating in every way we can that these policies have an effect on real people's lives. It's not about some fat cat in the corner getting his bonus nicked."

Byrnes is a senior writer for BusinessWeek. Berner is a senior writer in BusinessWeek's Chicago bureau. Elgin is a correspondent in BusinessWeek's Silicon Valley bureau. Epstein is a correspondent in BusinessWeek's Washington bureau.

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